Analysis of Supermarket Industry Structure in UK - Essay Example

Running Header UK supermarket Industry Analysis of Supermarket Industry Structure in UK Collage Analysis of SupermarketIndustry Structure in UK Markets vary in terms of their structures, and can operate under perfect or imperfect competition. An industry which operates under perfect competition, “there are large number of firms and none of them are large enough to hold and economic power over the industry” (Anderton 2003). Industries such as Farming fall under this category of market structures. In such markets, buyers have perfect knowledge of the products and there are no barriers to entry where firms can enter and set up new businesses or expand existing business. Products are homogeneous and undifferentiated. Those industries, which operate under imperfect competition, can be either monopolies or oligopolies. In such market scenarios, few or one supplier dominates the industry. The products are highly differentiated through branding and the market is further protected through barriers to entry, which can be either legal or natural. In case of monopolies such barriers can be imposed by government or by the economic realities such as high costs of capital and optimum supplier volume, which the market can absorb (Hall et al 2004). Figure 1 below illustrates the differences between markets, which are perfect and imperfect in competition. Figure 1 – Markets differing along the continuum of market control & competition None Greater Total Perfect Monopolistic Oligopoly Monopoly Competition Competition Many More None The supply and demand conditions in an oligopoly market are differentiated from that of perfect competition conditions. The difference is created by the demand inelasticity for below market prices and elasticity for above market prices, which results in a “kinked demand curve” as illustrated in figure 2. In the diagram below, the demand above the kink point of E is inelastic as prices of all firms in the oligopoly market remains unchained. Demand below the kinked point is elastic because such low prices will result in price cuts by fellow suppliers (Vives 1999). Figure 2 – Demand Conditions in Oligopoly Market The UK grocery retail business is one of the most dynamic sectors of growth in Europe with approximately 6% growth maintained over the years since 2002. The market value is in the region of £120 billion and the grocery industry is largely dominated by large-scale supermarket chains accounting for over 80% share of the value of sales. Supermarket sector of the retail grocery market comprise of the so-called “Big 4: chains, namely Tesco, ASDA, Morrison & Sainsbury followed by Summerfield, Marks & Spenser and Waitrose (Supermarkets in the United Kingdom 2006). Almost 75% of the UK grocery market is made up of the combined sales of the top four retailers and the market leader Tesco accounts for over 30% while ASDA raking second in terms of market share holds only half of the share of the market leader. Figure 2 & 3 in Appendix I provides an overview of the market shares of the key operators prior to and after the Safeway Takeover. With the industry being dominated by few suppliers, the UK supermarket industry operates under imperfect competition conditions, which is skewed towards an almost perfect oligapolistic market. Within the current oligopolistic market conditions, the pricing parity is closely maintained by the key players with an informal and implicit understanding of the need to do so for the benefit of all suppliers. Unlike in perfectly competitive markets where price wars erode the profitability, the oligopolistic conditions allow the retail chain operators enjoy above average profitability, which are termed as “abnormal profits” in economic sense. These market situations have led to “follow-the-leader” style of rival interactions where, other players are closely adopting the market leader’s positioning and pricing strategies. While Tesco and ASDA has already established themselves for their deep discounting practices, Morrison, too plan to follow suit by allocating over 500 million for the purpose of price reductions which will place them competitively against their two key rivals. With the new acquisition of Safeway, Morrison too now carries the required volume advantage to bargain lower costs in the supply chain (Safeway takeover 2003). With the oligopoly nature of the industry, the barriers to entry in the industry are high due to high investment costs preventing new entrants in to the market. The strong hold position of the existing players is also discouraging new entrants who would be unable to sustain head on price wars with companies as ASDA and Tesco who can practice below the cost pricing if necessary. Another natural barrier to entry in the industry is the long established brand names with strong marketing support. The industry operates on a highly differentiated platform which is evident in the total expenditure of approximately £150 million on advertising by key players. Such heavy advertising and promotional spend which the existing players are incurring in protecting and developing their brands further increases the entry costs and act as an entry barrier. The massive scale of operations of these key retail giants and the resulting imperfect competition in the industry have lead the authorities to intervene and curtail further expansions though Mergers & Takeover legislature as well as strict building laws. As per Office of Fair Trade regulations, companies are only allowed to expand through acquisitions only if they hold less than 25% of the industry and controversies were sparked when Tesco reported their expansion plans in the convenience stores category instead of the grocery stores sector in which they hold more than the 25% prescribed share. The level of government intervention in trying to control further expansions of the UK’s top retailers through acquisitions was further evident in its decision to block Tesco, ASDA and Sainsburry from taking over the Safeway chain while approving the bid of Morrison group which was ranking in fifth place prior to its takeover of Safeway. Morrison’s approval came with an attached condition of having to sell 50 outlets from its chain. (Morrison gets Safeway green light 2003). Another contender in this bidding rivelery, the Bhs stores owner Phillp Green pulled out of his own accord during the course of take over. With the completion of the takeover of Safeway the UK supermarket industry strcutre will come under renewed pressure with another larger scale operator in Morrisons coming in to rivelary with the top two players. The impact of the takeover is most likely to affect Sainsburry adversely, pressurising it for higher performance. With its smaller volumes, Sainsburry will face difficulties in tallying up to price competition being offered by Tesco, ASDA and newly enlarged Mrriosons. Sainburry purchased 14 of the 50 Morrison outlets which were offered on sale as a condition in the acquisition approval by Office of Fair Trade (Safeway (UK 2006). The take over of Safeway by Morrison is unlikely to affect the number one retailer Tesco, which is almost twice in size of its trading volume and with very strong, profit records registered continuously over the past years. However the forecasted price discounting of Morrison will place shorter price and profit pressures on Tesco if they choose to retaliate with further discounting of their own pricing. Tesco benefited from the Safeway deal of Morrison by purchasing 10 of the 50 Morrison outlets offered for sale. The takeover will also carry implications for UK suppliers to the supermarket industry where by, its most likely that Morrison too will now expand its global sourcing to keep costs competitive while bypassing the UK suppliers who are already finding it difficult to keep abreast with demands of low costs placed upon by them by retail giants such as Tesco and ASDA. Thus in conclusion it can be predicted that the UK supermarket industry will continue to operate as a strong oligopoly with a limited number of companies dominating and controlling over 80% of the market share. Pressure for growth may prompt further takeovers such as the likes of takeover of Safeway chain by Morrison, which will further consolidate the market power of key players. In future, the legislature on Fair Trade may have to become even more stringent to curtail industry leaders such as Tesco becoming a monopolistic behemoth, which will wield too much power over the industry and even hold power to drive out its key competitors such as ASDA and Morrison which hold less than half its’ market share. Bibliography Anderton, A (2003) Economics. 3rd ed. London: Causeway Press Limited. Hall, D., Jones, R. & Raffo, C. (2004). Business Studies. 3rd ed. London: Causeway Press Limited. Vives, X. (1999). Oligopoly pricing. London: MIT Press. “Safeway takeover: good news and bad” (2003) Food Navigator . com Retrieved November 29, 2006. from “Watchdog sets out Safeway fears.” (2005) CNN News. Retrieved November 28, 2006 from Supermarkets in the United Kingdom. (2006, November 26). In Wikipedia, The Free Encyclopedia. Retrieved November 30, 2006, from Safeway (UK). (2006, November 26). In Wikipedia, The Free Encyclopedia. Retrieved, November 30, 2006, from “Morrison seals Safeway takeover” (2004) BBC.Co.UK Retrieved November 29 2006 from “Morrison gets Safeway green light” (2003) BBC.Co.UK Retrieved November 29 2006 from Appendix I Figure 2 – UK Supermarket Industry Market Share (Prior to Safeway Take Over) Figure 3 - UK Supermarket Industry Market Share (After the Safeway Take Over) Read More